[Why&Next] Is Trump's 'Second Plaza Accord' Possible?

With the inauguration of the Donald Trump administration in the United States, there are prospects that an artificial dollar depreciation might be attempted in the future. Similar to the 1985 Plaza Accord, the Trump administration could enter negotiations to artificially prevent the appreciation of the dollar to reduce the U.S. trade deficit. However, unlike 40 years ago, the diversification of major dollar holders reduces the likelihood of cooperation, and even if negotiations are enforced, it could create a dilemma by further fueling domestic inflation concerns, making actualization difficult, according to analyses.

Even before the official launch of the Trump administration on the 21st, there were speculations about pursuing a second Plaza Accord. It is predicted that President Trump is highly likely to initiate a 'Mar-a-Lago Accord,' a second Plaza Accord, which involves artificially adjusting the dollar value to reduce the trade deficit. In 1985, the U.S. reached an agreement with Japan, France, Germany, and the United Kingdom to artificially depreciate the dollar value to reduce the trade deficit.

Steve Mnuchin, the nominee for chairman of the White House Council of Economic Advisers (CEA), who is known to be drafting Trump’s tariff policy, presented a report titled “Guide for Restructuring the Global Trading System” at the end of November last year, just before his nomination in December. In this report, Mnuchin argued that a high tariff policy is necessary to resolve the U.S. trade deficit and that a second Plaza Accord is needed to induce dollar depreciation. He suggested using tariff policy as leverage in negotiations to enforce agreements with major countries.

However, there is analysis that such a plan is unlikely to materialize. Unlike the global environment that allowed the 40-year-old Plaza Accord to be enforced, the diversification of major dollar holders today reduces the possibility of cooperation. Adam Posen, president of the Peterson Institute for International Economics (PIIE), recently told Asia Economy in an interview, “It is difficult to conclude a dollar-related agreement like the 1985 Plaza Accord,” adding, “Dollar holders have diversified from mainly Japan and Germany in 1985 to many countries now, including China, South Korea, Singapore, Indonesia, and Malaysia.”

He explained, “Forty years ago, Japan and Germany, which held large amounts of U.S. Treasury bonds, depended on the U.S. for national security, but now many major holders of U.S. Treasury bonds are not U.S. security allies.” The international situation has also changed since 1985, when the U.S. and the Soviet Union were sharply opposed during the Cold War. While the U.S. might be able to extract some currency appreciation from security-close countries like South Korea, Japan, and the U.K., it is difficult to seek cooperation from China and the Middle East. Furthermore, Posen said, “The financial market is much broader and deeper than in 1985, so the effect of exchange rate intervention excluding monetary policy has diminished,” and “due to inflation concerns and the Federal Reserve’s interest rate hikes, the dollar is expected to remain strong against most currencies for the next few years.” As a means to prevent a sharp rise in the dollar’s value, he predicted, “Rather than agreements like the Plaza Accord, extreme measures such as imposing taxes on U.S. Treasury purchases to reduce demand for dollar assets might be taken.”

In particular, the U.S. fiscal deficit and inflation are factors that make realizing an artificial dollar depreciation difficult. Professor Ha Jun-kyung of Hanyang University explained in a report published by Hana Bank’s Hana Financial Research Institute titled “Trump’s Second-Term Tariff Policy and the Possibility of a Second Plaza Accord” that even if a second Plaza Accord is enforced, there are many obstacles to actually driving down the dollar’s value.

Professor Ha said, “Even if East Asian countries cooperate to lower the dollar’s value, these countries will see a reduction in their trade surplus with the U.S. and the amount of dollars they earn will decrease.” In this case, demand for U.S. Treasury bonds will naturally decline. The problem is that Trump is implementing tax cuts, which are expected to increase the U.S. fiscal deficit in the future, so there is a high possibility of conflict between the two policies.

Professor Ha analyzed, “When the fiscal deficit increases and bond issuance rises, if East Asian countries, which used to absorb large amounts, no longer do so as before, it will become difficult to absorb these volumes domestically in the U.S., causing bond yields to rise.” He added, “The Federal Reserve might attempt to lower interest rates to mitigate these problems and reduce the dollar’s value, but this is not a simple issue.”

If the Trump administration pressures the Fed to ease monetary policy, concerns about rising prices will increase further. There are also inflation issues caused by rising import prices due to high tariffs and a reduction in low-wage labor due to illegal immigrant deportation policies. Professor Ha said, “In this case, accommodative monetary policy will become more difficult, but if monetary easing is forced, it will be perceived as undermining central bank independence, shaking the market along with inflation instability.” Therefore, Professor Ha added, “While the Trump administration is likely to want the possibility of a second Plaza Accord, the likelihood of such an attempt actually working is low.”